Government of Tanzania has decided to implement the depreciation policy to promote it's exports and assume further that Tanzania exports agricultural products to the rest of the world. Explain the impact of currency devaluation to the output to the balance of trade if:

Question

(I) farmers in Tanzania rely largely on domestic inputs
(II) A significant components of Tanzania's agricultural inputs are imported

Answer 1

(I) If farmers in Tanzania rely largely on domestic inputs, the impact of currency devaluation on the output of the balance of trade will depend on the price elasticity of demand for Tanzanian agricultural products.

If the price elasticity of demand is relatively elastic, meaning that a decrease in price will lead to a relatively larger increase in quantity demanded, then currency devaluation can potentially lead to an increase in exports. This is because the devaluation would make Tanzanian agricultural products relatively cheaper for international buyers, stimulating demand and increasing export volume. As a result, the balance of trade, which is the difference between exports and imports, may improve.

However, if the price elasticity of demand is relatively inelastic, meaning that a decrease in price will lead to a relatively smaller increase in quantity demanded, then the impact of currency devaluation on the output of the balance of trade may be limited. In this case, while Tanzanian agricultural products may become relatively cheaper for international buyers, the increase in quantity demanded may not be significant enough to offset the decrease in price. As a result, the balance of trade may not see a significant improvement.

(II) If a significant component of Tanzania's agricultural inputs are imported, currency devaluation can have a mixed impact on the output of the balance of trade.

On one hand, currency devaluation can increase the cost of imported inputs, potentially reducing the profitability of agricultural production. This can lead to a decrease in agricultural output and potentially decrease exports, negatively impacting the balance of trade.

On the other hand, currency devaluation can also make Tanzanian agricultural products relatively cheaper for international buyers. This can stimulate demand and potentially lead to an increase in exports, positively impacting the balance of trade.

The overall impact will depend on the combined effect of these factors. If the increase in demand resulting from cheaper exports outweighs the decrease in profitability due to increased input costs, then the balance of trade may improve. Conversely, if the decrease in profitability outweighs the increase in demand, then the balance of trade may worsen.